Buying an investment property.
Investing in property is one way of achieving your goal of increasing wealth but as with any investment it comes with a level of risk attached. If you’re considering investing in property it pays to understand the pros and cons. Join our live webinar to find out more.
Hi, I’m Bron Lawson from Westpac’s Davidson Institute. Here to talk to you about ‘Investing in property’. The Australian love of property means it often forms a significant part of many people’s investment portfolio. But, as with any investment, there is always an element of risk involved so getting informed on the basics of investing in property will help to minimise those risks and help you make the most of your investment.
Now, before I get into the good stuff, I do need to let you know that the information in this video is general in nature and has been prepared without taking your objectives, needs and overall financial situation into account. For this reason, you should consider the appropriateness of the information to your own circumstances and, if necessary, seek appropriate professional advice.
There are actually a number of ways that you can invest in property. The first way that most people think of is to purchase a property or properties to then rent out to someone else. Another option is to purchase a property to renovate then sell hopefully at a profit, or you can also purchase units in a property trust or a managed investment that purely invests in the property market.
The focus of our series of videos on Investing in property is the first option – to purchase a property to rent out. And we focus on residential properties, not commercial. This video looks at the basic principles of investing in property. We recommend that you also watch ‘Financing an investment property’ and ‘Measuring returns on your investment property’ to help get a broader spectrum of knowledge on investing in property.
Every investment has the elements of risk and reward. And property seems to fit the bill in having a good balance of the two. While sections of the Australian property market are somewhat subdued at the moment, others have experienced strong growth, historically it performs well compared to other investment types. And in terms of risk? The old adage ‘safe as houses’ rings true with many Australians – the solidity of that very tangible asset provides comfort and builds confidence.
But that balance of risk and reward isn’t the only consideration when thinking about investing in property. You also need to consider whether this type of investment fits with your overall financial goals and plans for your financial future.
The most successful investment strategies start with a clear understanding of what you want to achieve from investing. An important question to ask yourself is “What type of strategy makes the most sense for me and my financial future? Should my investment strategy be capital growth, cash flow, or a combination of the two?
Having this clear understanding is vitally important, because it gives you a solid purpose. Understanding exactly what you want to achieve from an investment then makes the ongoing decisions more focused and straight forward.
When it comes to property investing, one of the most common terms that you’ll hear is “negative gearing”, with the inference that it’s a core part of the investment property puzzle. The question that I get asked most often is “what is it?”
Gearing is simply the relationship between the income and the costs of an investment. The purpose of investing of course is to make more money on the money you have invested. In the case of investing in property that income is a combination of the rental income you earn throughout your ownership of the property, plus any capital growth, or increase in value.
Whether you’re positively or negatively geared depends on whether your income from the property covers your costs. Those costs being things such as property maintenance, property management, and interest on any loans. If your rental income exceeds your costs, you’re said to be positively geared. Because you’re receiving more cash than you’re paying out then this creates additional cash flow for you. Positive gearing supports a cash flow strategy.
If your rental income is less than your costs, you’re said to be negatively geared. This would support a capital growth strategy as you’re relying on the property growing in value over time. This does mean though that you’re making losses each year that you’ll need to cover from your other personal resources.
So, looking more closely at why you would choose either of these strategies. What is the appeal of a capital growth strategy, and why would you base your strategy on growth? Simply, as the value of the investment increases over time you can then use that to build further wealth.
The aim of course is that when you sell the property, the increased sales price will make up for the years of losses. You may also be able to offset annual losses against other income in your tax return to reduce your taxable income, but as always, we encourage you seeking professional advice about your specific circumstances before committing to either strategy. So, let’s look closer at why you would choose either of these strategies.
What is the appeal of a capital growth strategy, and why would you base your strategy on growth? Simply, as the value of the investment increases over time you can then use that to build further wealth.
But, of course, capital growth is not guaranteed. So, if this is our strategy then there are a couple of key questions to consider. Firstly, what is the realistic expectation for growth in the area where the property is located? And secondly, why will this property grow in value? What is it about this property that will enable it to grow in value?
To answer the question of why a property might grow in value, we need to understand the different factors that might come into play for the particular location. Population growth is a key driver of property value growth. As the demand for properties grows and supply dwindles, prices increase. While this isn’t the only driver of growth in the region, it’s a good example of the types of factors that influence changes at the local, suburban level.
Other examples include the demographics of the local neighbourhood. Such as whether the population is an aging one, full of young families, has high employment levels, and so on. Additionally, things such as proximity to public transport and amenities, future plans for development and major projects can be key influencing factors of whether a property increases in value over time.
So, it pays to do some research about the area that you’re looking to purchase in and be comfortable that the prevailing conditions suit your investment strategy.
Then, there’s the property itself. What features does it have, or what improvements can you make, that will enhance its value? It also helps to understand the historic trends for the area. For example, what have been the growth patterns in the past few property cycles? Is there an obvious period where it makes sense to buy, versus making sense to sell within that area? And check out recent property sales in the area to get a sense of how potential buyers are viewing this location right now.
You can find this information by keeping track of prices in the local real estate pages, or by accessing specific reports that either give insight into the local market or provide a more detailed price analysis of properties similar to the one that you’re looking for. The example on the screen comes from the realestate.com website and is a sample of the type of data that is now readily available and very useful in helping to select a property that supports your investment strategy.
The second strategy that can be employed is cash flow, or rental yield. Again, if a positive rental yield is your investment strategy, there are a couple of key questions to ask about the property. Questions such as, ‘what is a realistic yield for the area? And what features of the property are going to continue to enhance the yield?’
The yield from an investment property is simply the rent received less any expenses. There are 3 different types of yield outcome that can be achieved. These are positive, negative and neutral. Neutral simply means that the expenses equal the incoming rent. Negative means that you don’t earn enough in rent to cover the costs, and positive is the opposite, meaning that the incoming rent is greater than the outgoing expenses … creating positive cash flow.
In looking at what a realistic yield is for a particular area or location, there is plenty of information available online, such as the graph on the screen that shows data from CoreLogic of the average annual rental yield across the country to September 2021. The other question to consider is whether the yield that could potentially be achieved is comparable with other investment types. Given the risks associated with investing in property, is the return greater than a less risky investment.
The second question about why use a cash flow strategy, related directly to the features of the property that will attract tenants and rental returns. Improvements such as air-conditioning, car accommodation, or entertainment areas can set the property apart from its surrounding competition. Take care though that if you need to spend money on improvements that the improved return outweighs the cost.
Before investing in property, it pays to be aware of the risks. I’m going to start this discussion with the broader market and some important macro-economic factors. These are the factors that you’ll hear about on the daily news. Things such as GDP, unemployment and inflation. These indicate the general mood of the economy, and whether people are more likely, or less likely, to act in a particular way.
For example, if unemployment is high, then people may not be as willing to purchase new property, which might mean the value of our investment property may flat line for a period of time, or perhaps even go backwards. It’s also important to consider when you’ll make the purchase. Property values generally run in cycles. For example, if you buy at the peak of the cycle, you may be paying a high price for the property, and either the value may not grow as quickly as you like, or even at all.
Economists often talk about a ‘clock’, which walks through the various stages of the cycle. It’s useful to understand the nature of this economic clock, and what it might mean for when you choose to invest in a property. Let’s start where prices are at their peak. This is the top of the investment cycle. As people are attracted to sell at good prices, it tends to lead to having a high supply of properties.
With a potential oversupply this then leads to a slowing investment environment and flattening rents.
Meaning that prices soften. As investors become more inactive developers slow their work as well and housing stocks start to decline. Then comes the lowest point of the property cycle where prices trough, leading to a lower supply of houses. With a low supply of houses, rents start to rise. This of course is attractive to investors, and they tend to start to increase their activity again.
Causing prices to rise. Developers return in force, there is strong investment and housing stock builds again as prices increase. This clock is driven, in part, by macro-economic factors such as Gross Domestic Product, jobs growth and inflation. But understanding this cycle will help give you some insight into when is potentially a good time to buy.
There are also some more localised risks. Remember the drivers of growth we looked at earlier? If these drivers are absent, or reversed, then the property may be in an area that will not provide the right environment for growth at all. So, do your location research thoroughly before committing to buy.
Then there are the risks associated with the property itself. Firstly, not having a tenant is going to impact your cash flow and rental return. The type of tenant you have is also important. If you have the wrong tenants in your property, you may run the risk of late payment of rent, or even damage to the property. Ensuring you have Landlord’s insurance is one way of mitigating these risks. It’s also worth discussing the best strategies for managing this with a professional property manager.
Which brings us to our next consideration of ongoing management of the investment. Property, unlike some other forms of investment, is not ‘set and forget’. There are a number of things that need to be regularly addressed in order to get the most out of your investment. How are you going to manage things like: • marketing the property? • tenant selection? • rent collection? • and maintaining the property?
If the property is vacant for any period of time this could cause a significant impact on your cash flow. How do you manage this? Do you have sufficient income from other sources to cover the shortfall? Do you need to adjust things such as your tenant criteria, preferred lease term, or even the rent to keep your property tenanted? Then you also need to understand and consider the legal aspects of the landlord/tenant relationship.
With regard to the ongoing property management, you have a choice as to whether to manage the property yourself, or to engage the services of a professional property manager. The answer will depend on your cost/benefit viewpoint.
So why might you choose to manage the property yourself? To start with, you might simply have a desire to do it yourself. You may live close enough to keep an eye on it, or you may have family or friends for tenants. You may have the skills to take care of maintenance, rent collection and even marketing the property. Remember though that this is going to cost you time, energy, and focus and you’ll need to do your own market research to stay informed.
On the other hand, you may not have either the skills or desire to do this yourself, so you’ll engage a professional property manager. Consider carefully both the costs and benefits involved. For a fee, a property manager can take care of the various components of your investment property, which should enable you to focus your energies on growing your investment portfolio.
So, to round out this video let me share with you our top 5 tips for successful property investing.
Number 1 – remember property is a long-term investment. No matter whether you’re looking for capital growth or cash flow, both of these should continue to improve over time. Number 2 – speaking of capital growth or cash flow, to be successful for you, it’s important that you’re clear on the strategy for this particular property and that investing in property suits your overall investment strategy and risk profile.
Number 3 - That strategy will also dictate the type of property that you decide to invest in. Remember the property needs to be in a location and have the features to attract good tenants and provide a sound return for you. Take the time to do plenty of research to give yourself the best chance of a good result.
Number 4 - For your property to achieve the financial returns you’re looking for then you’ll need to ensure that ownership and property finance are correctly structured to suit your situation. We’ll cover structuring of finance in more detail in our next video in this series on ‘Financing an investment property’.
And finally, remember this is an investment … a business if you like, intended to make money for you. Don’t buy the property because you like it and may like to live in it yourself one day. This rarely ends up being the case and potentially means you may not achieve the return you’re looking for from the investment. It’s not personal, it’s a money-making venture and needs to be viewed as such.
We’ll also cover more about measuring the returns on your investment property in the 3rd and final video in this series, because for it to be a successful property investment you need to understand how the property stacks up against your goals and in comparison to other investment types. So, the key points we’ve covered briefly are …
The different strategies you might employ when investing in property and we looked at some of the ins and outs of capital growth and cash flow strategies. We had a look at some of the risks associated with investing in property – both macro-economic factors and those closer to home. And finally, we looked at some of the ongoing considerations around property management.
We hope you’ll take the time to watch the other 2 videos in this series on ‘Financing an investment property’ and ‘Measuring returns on an investment property’ as getting your finance correctly structured is one of the keys to achieving the returns you’re looking for from investing in property.
Thank you for watching our video on ‘Investing in property’. I hope you found it helpful and I encourage you to check out the other resources on the Davidson Institute website to help build your financial confidence. Bye for now.